College Endowments Learn to Live With Risk

By EDWARD WYATT

Published: November 19, 2000

Correction Appended

SOME years it is the football coach. Others, the Nobel Prize-winning physicist. This year, however, the biggest celebrities among college faculty members and administrators sit not in the field houses or the science labs but in the investment offices, where they have guided endowments to record gains.

The group that oversees Duke University's endowment steered its $1.7 billion pool of capital to a 59 percent gain in the year ended June 30. The University of Notre Dame's investments gained 58 percent in the same period, those of the Massachusetts Institute of Technology jumped more than 50 percent, and at least six other large universities recorded investment returns exceeding 40 percent. Harvard's 32 percent profit generated $4.6 billion for the university, more than the total endowment of all but seven other American colleges.

While other investors have enjoyed similarly stellar returns in the last few years, the profits reaped recently by university endowments contrast with the staid reputation that such funds have long had, particularly among alumni eager to see their contributions invested wisely.

Those profits were generated by taking no small amount of risk -- including a heavy reliance on speculative venture capital, or private equity, where investors bet on companies at such an early stage that an entire investment can be wiped out before a product or service even gets to market.

Propelled by the roaring stock market, however, venture capital has produced triple-digit returns for many endowments by letting them make early bets on companies like eBay, Phone.com and Sycamore Networks. The biggest risk often seemed to be in having too few such investments.

Until now. Even some of the biggest fans of venture investments are warning that the rich recent returns are not likely to last.

''A lot of the money going into private equity now, I think, is going to generate very disappointing returns,'' said David F. Swensen, the chief investment officer at Yale and the man whom many of his peers credit with forging the new theory of aggressive endowment investment.

Indeed, recent stock market weakness, including a 40 percent fall in the Nasdaq composite index since its peak in March, has caused private-equity portfolios to give back some of the gains and raised questions about when and how well those investments actually diversify a portfolio.

Yet many colleges and universities that previously failed to move much money into the riskier assets are now trying to do so. Those schools, including the University of Pennsylvania and the University of California, face the danger of buying overpriced investments just as their value is beginning to fall.

''Institutions that were primarily focused on large-cap U.S. stocks and bonds are now saying, 'Maybe I'll make some investments in these other places,' '' said Todd E. Petzel, chief investment officer for the Commonfund, which invests more than $26 billion for 1,400 colleges and universities in the United States and Canada. ''But this may be an awkward time to do that. An awful lot of people are coming to this party awfully late, and they have experience only in good equity markets.''

BOTH the success and the peril wrought by the performance of venture capital investments is evident at Notre Dame, where the university's venture capital investments rose 400 percent in value last year. At one point, they accounted for about 40 percent of its $3 billion endowment.

By late last month, that had fallen to about 35 percent, in part because of the sale of some stock holdings, said Scott Malpass, who manages the fund. Also taking a toll, however, was the Nasdaq's tumble, which cut the value of many companies that had only recently graduated from venture capital investments to publicly traded stocks and were still in the endowment's portfolios.

While the recent stock market decline has dented the financial strength of some universities, most are still better off than they were a decade ago, when colleges around the country were cutting academic programs and letting faculty and administrative jobs go unfilled because of financial woes.

Today, some of the wealthiest universities are experiencing a period of great prosperity. With hundreds of millions of dollars unexpectedly in hand, institutions are enjoying an unrivaled period of building and expansion. That growth has untold economic benefits for the communities around colleges and universities.

''The performance of the endowment in the last several years has certainly given us the ability to do new things,'' said Jeremy Knowles, the dean of the faculty of arts and sciences at Harvard. Among them are new academic initiatives like creating centers for the study of genomics and American political science. More mundane tasks ''that should have been done 85 years ago'' have also been attended to, he said, including air-conditioning the rooms holding valuable library collections.

So far, in most cases, increased spending has not come at the expense of the endowments' capital. Yale's endowment has grown to $10 billion from $1 billion when Mr. Swensen arrived in 1985, even as its contribution to the annual budget has risen to nearly 30 percent from 10 percent, he noted. Yet that contribution still accounts for less than 5 percent of the endowment's assets.

Correction: November 26, 2000, Sunday An article last Sunday about investments by university endowments in venture capital and other types of private equity referred incorrectly to those of the University of California. While the university changed its policy this year to allow up to 7 percent of its endowment pool to go to such investments, from 2 percent, the change simply brought policy into line with practice. About 5 percent of the endowment's assets have been invested in private equity for several years.